Will the last bear in the room please stand up?

Bitcoin frenzy has echoes of the dotcom boom

Investors and traders are often said to have short memories. Yet those who have been around for a few decades or more will no doubt recall the gut-wrenching falls in stock markets as the dotcom bubble collapsed in 2000, and then again as the 2008 financial crisis unfolded.

Traders with a memory deficit should not blame themselves. Their role is to follow the direction of securities and make a profit. But investors have a duty to themselves to be more wary. The usual advice here is not to put all your eggs in one basket, diversify your investments and don’t jump on bandwagons that are rolling a little too fast.

Recent private investor interest in bitcoin and other cryptocurrencies (‘bitcoin’ is the top-ranked search term on Google) is a clear signal of euphoria breaking out. To say it’s all a bit speculative would be the investing understatement of the 21st century.

Echoes of bubbles past

Interest in initial coin offerings (ICOs) is soaring, with current offers using blockchain tech to disrupt industries from dentistry to social networking, finance and advertising. If you’re really interested in this stuff, take a look at www.coinschedule.com for a list of current ‘investment’ opportunities and a pipeline of upcoming ICOs.

The growing crypto-mania brings back very strong memories from 20 years ago as the dotcom bubble started to swell. New-age Will the last bear in the room please stand up? stockbrokers sprang up with very swanky front offices, often staffed by outrageously beautiful people, to entice gullible investors to back the latest internet venture before it was launched on the stock market as an initial public offering, and to reap the riches that would come their way as a matter of course.

This frenzied interest in the development of cryptocurrencies might follow a similar path to the dotcom bubble. Not many people understand how blockchain ledgers work and I don’t pretend to be one of them. But one only needs to see how internet technology has developed in the past 20 years, and the winners that have emerged, to get an idea of how blockchain technology might progress.

Today’s giants of the internet age continue to draw excitable crowds of investors, and for good reason: these businesses have made a lot of money. So have their shareholders, as demonstrated by the performance of ‘bats with faangs’ in 2017. Shares in the Asian internet giants Baidu, Alibaba and Tencent gained an average 80 per cent last year; while US behemoths Facebook, Amazon, Apple, Netflix and Google (now annoyingly called Alphabet) rose an average 60 per cent.

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These examples indicate euphoria in abundance. Momentum-driven investing, also known as ‘let the trend be your friend’, has had another highly successful year. The MSCI World Momentum index returned 31 per cent in local currency terms in 2017, double that of the equivalent World Value index.

Stock market bulls will point out that the growth spurt in global economies is supportive – but that was also the case in 2008. I remember all too well, to my eternal embarrassment, writing a column a few months before the crisis broke, which confidently stated there seemed no reason to be fearful of the global stock market’s upward trajectory, and that investors should let the trend be their friend.

Reasons to be cheerful

Plenty of commentators and professional investors today are providing similarly decent reasons for the bull to keep on running. One is Russ Mould, investment director at investment platform AJ Bell, who has analysed five stock market charts to illustrate why stocks should continue to gently move up.

The first looks at transportation indices in the US and the UK. They have been strong on a one-year view, which indicates that plenty of goods are being made, sold and shipped to customers. The second looks at copper, which hit a six-year trough in 2016 and has been rising steadily since. In 2017 its price rose by nearly 25 per cent, which is a good indicator of global economic health.

The third indicator looks at the strong performance of small companies – a good indicator of good economic health. Small-cap indices have certainly powered ahead in the UK over the past year, while also making solid if unspectacular progress in the US. ‘Bulls will want to see these benchmarks keep ticking higher and their gains so far offer a positive sign,’ says Mould.

The fourth indicator concerns volatility (more on US volatility later). In 2017, the FTSE 100 registered only 17 daily open-to close moves of more than 1 per cent, the lowest since 2005. ‘Further peaceful gains, in incremental steps, would further encourage this as a bull run and not some frenzied bubble that is primed to burst, assuming historic trends repeat themselves,’ says Mould.

Last, and most important, is valuation. Rather than focus on forecast earnings, which are fallible, investors should focus on dividend yield. Currently the All-Share index offers a yield of 3.6 per cent, which is 230 basis points above the yield on 10-year UK gilts. Mould points out that only twice since 2008 has the All-Share index offered a yield of 2 percentage points more than 10-year gilts and on both occasions the index went on to make healthy gains.

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However, although dividends are usually the last thing that company managements will want to cut, investors should also note that dividend cover (the ratio of a company’s earnings to the amount paid out in dividends) for FTSE 100 companies has fallen to 1.63, its lowest point since the financial crisis, according to AJ Bell’s own Dividend Dashboard survey.

The fear factors

All five indicators are suggesting it’s all systems go for another leg to the bull run. However, Mould adds a caveat, which I strongly agree with. ‘After what is now almost a nine-year bull run in UK stocks, even that could be a reminder of Warren Buffett’s aphorism that the right time to be fearful is when everyone is greedy and the right time to be greedy is when everyone is fearful. Right now there is little, if any, fear in evidence.’

There may be little fear, but there is trepidation in abundance. Albert Edwards, the famously bearish strategist at French bank Société Générale, recently wrote that ‘many clients we meet are fully invested bears, nervously looking over their shoulder for signals of the next Great Unwind,’ adding at a conference for investors in January that even the biggest market bears are ‘being forced to participate in the madness’.

Leaving geopolitical risks to one side, the same old concerns have investors worried. First is the cyclically adjusted price/earnings ratio over 10 years. The Cape for the US S&P 500 index has been rising steadily – since I last mentioned this in July, when Cape was around 29, it has risen to 33.2. The last two years of the dotcom bubble saw it rise higher, to 44. But it is worth pointing out, again, that Cape is higher than on the eve of the crash of 1929.

While the bull market grinds on, people have started to give up on the abilities of Cape to act as a predictor of overvaluation and an impending bear market. But Cape can be viewed as a predictor of future returns. As the team behind the Newton Real Return fund have stated: ‘What we can be sure of is that, as this bull market continues and valuations ratchet ever upward, the risk/reward becomes more skewed to the downside. The longer-term returns investors should expect at current valuations are now very low indeed, and reversion to a more “normal” earnings multiple would be likely to herald a significant drawdown.’ That might sound familiar as it is a quote I have lifted from my July column, when the S&P 500 index stood at around 2450. Today it is 12 per cent higher at 2750.

Meanwhile, persistently low volatility continues to worry some and it is breaking records: 2017 heralded the calmest year in the US stock market since 1964, as measured by the CBOE Vix index. Huge flows into exchange traded funds (ETFs) that bet against volatility have played a part in keeping it down, while many market-watchers suspect that even larger flows into index-tracking equity funds are also doing their bit to prop up equity indices. ‘Valuations be damned, we’re all making too much money to care,’ is the motto of the day.

Lastly, there is the persistent concern of a looming bear market in bonds after 30 years of bull. Although government bond prices have started to fall and yields are slowly rising as an estimated $15 trillion worth of quantitative easing is wound down, investors seem not to care that much what central banks are telling us: that infl ation is rising, interest rates are going up and, very soon, the banks won’t be buying any more bonds.

No one can accurately forecast what draining the QE punch bowl will mean for government bond markets, or the knock-on for equities and corporate bonds. But there is a growing body of opinion that investors have vastly underestimated the consequences. No one wants to get off the merry-go-round while the organ-grinder’s still playing – but the tune is wearing a bit thin. 

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